1031 Exchanges and Your Collectibles
By Karl Chiao
Section 1031 of the IRS Tax Code (commonly referred to as a 1031 Exchange) is a tax strategy often used in the real estate world to defer long term capital gains when one sells their real property. Basically, how this works is when a person sells real property that includes a capital gain, that person can then reinvest that money by taking the proceeds from the sale and buying another piece of property "of like kind" within a specified time to replace the piece sold — and thus deferring any possible tax gains.
While the use of the 1031 exchange has been around in the real estate world for many years, most people are not aware that the 1031 exchange can also be applied to the sale of collectibles as long as it satisfies certain IRS requirements. Here are the basics of the 1031 exchange as it applies to collectibles:
- There is an exchange of property that qualifies under 1031: This just means that you have to sell something that is considered a collectible and then buy something that is collectible to replace it. The kicker is that after you sell your collectible, you only have 45 days to identify the replacement item(s) and 180 days to complete the purchase of that item(s). If you miss either of those deadlines, the tax benefits from doing the exchange will be forfeited.
- The properties exchanged are like kind to one another: "Like kind" in this instance refers to the nature or character of the collectible, and NOT its grade or quality. This where we see the most problems. Not only are coins and currency considered not like kind, but the IRS has ruled that collectible coins are not like kind to gold bullion and gold bullion are not like kind to silver bullion, etc. What about exchanging paintings for sculptures... you get the idea. While works of art are not as well defined by the IRS as for other types of collectibles, we have seen acceptable exchanges of "art" for "art" without the delineation of the medium of the works. Thus, a watercolor on paper might be considered of like kind to on oil on canvas. Keep in mind that once the first item is sold, a Qualified Intermediary ("QI") must hold the proceeds from the sale in escrow until the new item is purchased.
- Both properties are held for investment, or used productively in a trade or business: the burden falls on the collector/investor that whatever he collects was for investment purpose with the goal of making a profit. As in any investment, gains taxes are based on various holdings conditions, such as the length of time of the holding.
While the concept of a 1031 exchange is fairly straightforward, specific rules involving the 1031 exchange in each individual's situation can be quite a bit more complicated. It is essential that you consult with a certified tax professional before you decide to do the exchange.